15 Tax Deductions and Benefits for the Self-Employed

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15 Tax Deductions and Benefits for the Self-Employed

Over the years, lawmakers have included various lines into the tax code to cushion the impact of the additional expenditures that self-employed individuals must bear while doing business. The Tax Cuts and Jobs Act (TCJA), which went into effect for the 2018 tax year, makes a number of modifications to self-employment tax deductions. Many of these modifications are just temporary and will be phased out by 2025, while others are permanent.

The legislation impacts small companies in a variety of ways, most notably via a qualifying business income (QBI) deduction for pass-through enterprises—those that pay taxes as individuals rather than corporations.

This deduction is very beneficial to owners of sole proprietorships, partnerships, S corporations, and certain trusts, estates, and limited liability organizations (LLCs). Taxpayers who qualify may deduct up to 20% of their QBI. The net amount of eligible items of income, gain, deduction, and loss from a qualified trade or company is the QBI of a pass-through.

Key Takeaways

  • The Tax Cuts and Jobs Act (TCJA), which went into effect in 2018, made a number of modifications to self-employment tax deductions.
  • If you are self-employed, it is important to assess what you may deduct each year in order to keep your firm as successful as possible.
  • A deduction for a home office and a car used for business purposes may be calculated in two ways. It is worthwhile to do calculations for both ways to determine which is more financially advantageous.
  • Meals with clients and business trips are deductible, but meals involved in entertainment may not be, according to the Tax Cuts and Jobs Act.
  • Premiums paid for insurance to safeguard your company and for health insurance are both legal deductions. Don’t forget about startup, advertising, and retirement plan expenses.

Eliminated or Changed Deductions

Following the TCJA, the following deductions were removed or changed:

  • Deduction for entertainment and fringe benefits
  • Deduction for parking, public transportation, or commuting expenditures for employees
  • Deduction for domestic manufacturing activities
  • Deduction for local lobbying expenditures
  • The deduction for state and local taxes (SALT) is now restricted to $10,000 ($5,000 if married filing separately).
  • Deduction of settlement or legal expenses in a sexual harassment complaint where the settlement includes a nondisclosure clause.

Key provisions that are set to expire in 2025 include:

  • QBI deduction
  • SALT deduction cap
  • The standard deduction will revert to its pre-TCJA levels.
  • Tax rates on income will revert to pre-TCJA levels.

It should be noted that tax rules are continuously changing, and these provisions might be amended or expanded at any time before 2025. To keep you up to speed on any necessary adjustments to your quarterly anticipated tax payments, a review of the most frequent self-employed taxes and deductions is required.

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1. Self-Employment Tax Deduction

The Medicare and Social Security taxes that self-employed persons must pay are referred to as the self-employment tax. Freelancers, independent contractors, and small-business owners are all included. The self-employment tax rate is 15.3%, including Social Security at 12.4% and Medicare at 2.9%.

The self-employment tax is shared by both employers and workers. Each contributes 7.65%. People who are completely self-employed pay both portions. If your income exceeds a specific level, you will be subject to an extra 0.9% Medicare tax rate. The following are the threshold figures:

  • $250,000 if married filing jointly
  • $125,000 if married filing separately.
  • Single: $200,000
  • Head of household: $200,000 (with qualified person)
  • $200,000 for a qualifying widow(er) with a dependent child.

The higher Medicare tax thresholds apply not just to self-employment income, but also to your total salary, compensation, and self-employment income. So, if you earn $100,000 from self-employment and your spouse earns $160,000 from employee salaries, you must pay an extra 0.9% Medicare tax on the $10,000 that your combined income surpasses the $250,000 level.

It’s not pleasant to pay additional taxes to be your own boss. The good news is that you can deduct half of your self-employment tax from your net income when calculating your income tax, so the self-employment tax will cost you less than you think. The Internal Revenue Service (IRS) considers the employer component of the self-employment tax to be a business cost that may be deducted.

Social Security and Medicare Taxes

It is vital to highlight that the self-employment tax refers to Social Security and Medicare taxes, which are equivalent to the FICA tax paid by an employer. When a taxpayer deducts one-half of the self-employment tax, it is exclusively for the purpose of calculating the taxpayer’s income tax. It has no effect on net self-employment earnings or the self-employment tax itself.

Remember that whether you work for yourself or for someone else, you must pay the first 7.65%. When you work for someone else, you are indirectly paying the employer part since it is money that your employer cannot afford to add to your compensation.

Self-employed people calculate their net income from self-employment and deductions using their preferred accounting technique. Most self-employed people use the cash method of accounting, which means they will include all money received actually or constructively during the period, as well as any deductions made during the period, when calculating their net income from self-employment.

2. Home Office Deduction

One of the most complicated deductions is the home office deduction. In summary, you may deduct the cost of any workspace that you use frequently and solely for your company, whether you rent or own it.

You are essentially on the honor system, but you should be prepared to defend your deduction if an IRS examination occurs. If you are required to submit this information to substantiate your deduction, which uses the square footage of your workspace in its calculation, one way to do this is to prepare a diagram of your workspace with accurate measurements.

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In addition to the office space itself, you may deduct the following expenditures for your home office: business portion of deductible mortgage interest, house depreciation, utilities, homeowners insurance, and repairs paid throughout the year.

If your home office takes up 15% of your living space, for example, 15% of your monthly power expense is tax deductible. Some of these deductions, such as mortgage interest and house depreciation, are only available to people who own their home office space rather than renting it.

How to Calculate the Home Office Deduction

You may calculate your home office deduction in two ways: the normal approach or the simplified technique, and you don’t have to use the same method every year. In the case of an audit, the normal procedure requires you to determine your real home office expenditures and maintain complete records.

The simple option allows you to multiply an IRS-determined rate by the square footage of your home office. The simplest option requires that your home office be no greater than 300 square feet, and you cannot claim depreciation or home-related itemized deductions.

If you’re short on time or can’t keep solid records of your deductible home office costs, the streamlined alternative is a no-brainer. The simple alternative, on the other hand, is computed at $5 per square foot, with a limit of 300 square feet, so the most you may deduct is $1,500.

If you want to maximize your home office deduction, you should calculate it using both the conventional and simplified techniques to see which one gives you the most advantage. If you use the normal approach, use IRS Form 8829, Expenses for Business Use of Your Home, to compute the deduction.

3. Internet and Phone Bills Deduction

You may deduct the business part of your phone, fax, and Internet expenditures whether or not you claim the home office deduction. The trick is to only deduct costs that are directly relevant to your company. You might, for example, deduct the Internet-related expenditures of hosting a company website.

You should not subtract your full monthly payment, including personal and commercial usage, if you just have one phone line. “You cannot deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your house, even if you operate an office in your home,” according to the IRS. You may, however, deduct the whole cost of long-distance business calls or the expense of a second phone line devoted only to your firm.

4. Health Insurance Premiums Deduction

You may deduct all of your health, dental, and qualifying long-term care (LTC) insurance premiums if you are self-employed, pay for your health insurance premiums, and are not eligible to join in a plan via your spouse’s job.

You may also deduct premiums paid to provide coverage for your spouse, dependents, and children under the age of 27 at the end of the year, even if they aren’t dependents on your taxes. Calculate the deduction using the IRS Publication 535 Self-Employed Health Insurance Deduction Worksheet.

5. Meals Deduction

When traveling for business, attending a business conference, or entertaining a client, a lunch is a tax-deductible business cost. Under the circumstances, the meal cannot be extravagant, and in the past, you could only deduct 50% of the actual cost of the meal if you kept your receipts, or 50% of the standard meal allowance if you kept records of the time, place, and business purpose of your travel but not your actual meal receipts. Unfortunately, this implies that the desk meal is not deductible as a business expense.

According to the Consolidated Appropriations Act (CAA), 2021, H.R. 133, Temporary authorization of a full deduction for business lunches, the deduction has been changed. The measure permits a temporary 100% business cost deduction for meals (rather than the existing 50%) if the expense is for food or drinks supplied by a restaurant. This provision applies to expenditures incurred after December 31, 2020, and it expires at the end of 2022.

The standard meal allowance is the federal Meals and Incidental Expenses (M&IE) rate, which is revised every fiscal year and goes into effect on October 1. The current rate and M&IE split may be found on the General Services Administration (GSA) website in the United States. Lunch eaten alone at your workplace is not tax deductible.

Furthermore, prior to the TCJA, meals and entertainment charges were combined. According to the IRS, “if food or beverages are provided during or at an entertainment event, and the food and beverages were purchased separately from the entertainment, or the cost of the food and beverages was stated separately from the cost of the entertainment on one or more bills, invoices, or receipts, you may be able to deduct the separately stated costs as a meal expense” for tax years 2018 and later.

However, if the meals are not specified individually on the receipt, they cannot be deducted at all.

6. Travel Deduction

To be eligible for a tax deduction, business travel must be longer than a typical workday, require you to sleep or relax, and take place outside of your tax residence (usually, outside the city where your business is located).Furthermore, to be deemed a business trip, you must have a clear business goal planned before leaving home, and you must actively participate in business activities while on the road, such as discovering new customers, meeting with clients, or acquiring new skills directly linked to your firm.

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Giving out business cards during a bachelor party in Las Vegas does not qualify your vacation as tax deductible.

Maintain comprehensive and precise records and receipts for your business travel costs and activities, since the IRS often scrutinizes this deduction. Transportation to and from your trip (such as aircraft flight), transportation at your location (such as vehicle rental, Uberfare, or metro tickets), hotel, and meals are all deductible travel costs.

You cannot deduct expensive or wasteful charges, but you are not required to use the lowest solutions available. But bear in mind that you, not your fellow taxpayers, will be paying the majority of your business travel expenses, so it’s in your best interest to make them affordable. Except for meals, which are restricted to 50%, your business travel costs are fully deductible. If your vacation includes work and pleasure, the situation becomes much more convoluted; in a nutshell, you may only deduct costs linked to the business component of your trip.

For example, if your spouse (who is not an employee of your company) accompanies you on a business trip, you may only deduct the part of housing and transportation expenditures that you would have paid if you had gone alone. Remember that the business portion of your trip must be prepared ahead of time.

7. Vehicle Use Deduction

When you use your automobile for business purposes, your travel expenditures are tax deductible. Keep meticulous records of the date, distance, and purpose of each travel, and avoid claiming personal vehicle excursions as work car trips.

You may compute your deduction using either the IRS’s standard mileage rate or your actual expenditures. In 2021, the regular mileage rate is 56 cents per mile, rising to 58.5 cents per mile in 2022. Using the normal mileage rate is the simplest option since it needs the least amount of record-keeping and calculating. Simply record the business miles you travel and the days you travel. Then double your yearly business mileage total by the usual mileage rate. This is your tax-deductible cost.

To utilize the real expenditure technique, you must compute your proportion of business driving for the year as well as the overall cost of running your automobile, which includes depreciation, petrol, oil changes, registration fees, repairs, and car insurance. If you spent $3,000 on automobile expenditures and drove for business 10% of the time, your deduction would be $300.

If you wish to utilize the normal mileage rate on a car you own, you must do so during the first year the vehicle is accessible for business use. In subsequent years, you may utilize either the normal mileage rate or actual expenditures. If you are leasing a car and want to utilize the normal mileage rate, you must do so in each year of the lease duration. As with the home office deduction, it may be worthwhile to calculate your deduction both ways so that you may claim the higher amount.

8. Interest Deduction

Bank interest on a company loan is a tax-deductible business expenditure. If a loan is utilized for both business and personal reasons, the business component of the interest cost is allocated depending on how the loan funds are used.

If the full loan is not utilized for business-related operations, you will need to monitor the distribution of cash for other reasons. Credit card interest is not tax deductible when used for personal expenditures, however it is tax deductible when used for business purchases.

However, it is usually better to spend just what you currently have and avoid incurring any interest fees. A tax deduction only returns a portion of your money; thus, avoid borrowing money. Borrowing, on the other hand, may be the only method for certain firms to get up and running, to maintain the company during sluggish times, or to ramp up during busy seasons.

9. Publications and Subscriptions Deduction

Specialty periodicals, journals, and books directly linked to your company are tax deductible as supplies and materials.

A daily newspaper, for example, would be insufficiently detailed to be called a business cost. If you run a restaurant, a subscription to Nation’s Restaurant News is tax deductible, and Nathan Myhrvold’s several-hundred-dollar Modernist Cuisine boxed set is a reasonable book buy for a self-employed, high-end personal chef.

10. Education Deduction

Any school costs that you wish to deduct must be connected to maintaining or upgrading your abilities for your current company. Classes to prepare for a new field of employment are not tax deductible.

If you’re a real estate consultant, completing a Real Estate Investment Analysis course to sharpen your abilities is tax deductible, but learning how to teach yoga is not.

11. Business Insurance Deduction

Do you pay premiums for any sort of business insurance, such as fire insurance, credit insurance, business vehicle insurance, or company liability insurance? If so, you may be able to deduct your premiums.

Some individuals dislike paying insurance premiums because they consider them a waste of money if they never need to submit a claim. The company insurance tax deduction may help alleviate this aversion.

12. Rent Deduction

You may deduct the amount you spend for office space if you rent it out. You may also deduct payments spent for rented equipment. If you have to pay a fee to terminate a company lease, that expenditure is also tax deductible.

However, you cannot deduct rent on any property that you own, even if just partly. In addition, the rent must be affordable. A reasonableness test is usually required when you and the owner are connected, but rent is lawful if it is the same amount you would pay to a stranger.

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13. Startup Costs Deduction

The IRS normally requires you to deduct big costs as capital expenses over time rather than all at once. However, in the first year of active trade or company, you may deduct up to $5,000 in business starting expenditures.

Market research and travel-related expenditures for beginning your company, scouting out possible business sites, advertising, legal fees, and accountant fees are examples of tax-deductible startup charges. If your overall starting costs surpass $50,000, your $5,000 deduction is decreased. You may deduct up to $5,000 more in organizational expenditures, such as state filing fees and legal fees, if you form a corporation or LLC for your firm.

Professional fees paid to consultants, lawyers, accountants, and others are also tax deductible at any time, even if they are not initial expenditures.

Purchases of equipment or cars, for example, are not considered starting costs, but they might be discounted or amortized as capital expenditures.

14. Advertising Deduction

Do you spend money on Facebook or Google advertisements, billboards, television commercials, or postal fliers? The expenditures of advertising your company are tax deductible.

You can even deduct the cost of an ad that encourages people to donate to charity while also putting the name of your business before the public in the hope of gaining customers. For example, a sign advertising “Holiday Toy Drive sponsored by Robert’s Hot Dogs” would be tax deductible.

15. Retirement Plan Contributions Deduction

One deduction that you can take going into business for yourself that is especially worthwhile is the deduction for self-employed retirement plan contributions. Contributions toSimplified Employee Pension-individual retirement accounts (SEP-IRAs),Savings Incentive Match Plan for Employees (SIMPLE) IRAs,andsolo 401(k)sreduce your tax bill now and help you rack up tax-deferred investment gains for later.

For the 2021tax year, for example, you could feasibly contribute as much as $19,500 in deferred salary (or $26,000, with the $6,500 catch-up contribution, if you’re 50 or older). In 2022, that amount goes up to $20,500, with the $6,500 catch-up contribution. Plus, you can contribute another 25% of your net self-employment earnings after deducting one-half of self-employment tax and contributions for yourself.

With a self-employed 401(k), the total maximum contributions cannot exceed $58,000 for 2021 and $61,000 for 2022 (not counting catch-up contributions of $6,500, if eligible) for both employee and employer contribution categories. Contribution limits vary by plan type, and the IRS adjusts the maximums annually. Of course, you can’t contribute more than you earn, and this benefit will only help you if you have enough profits to take advantage of it.

SEP Account: Jessica Perez

I Rent My Home. Do I Qualify for the Home Office Expense Deduction?

Yes, you can qualify for the home office expense deduction if you meet all of the business use requirements. A renter can use the simplified method or actual expense method based on the percentage of the home that is dedicated to business use.

Is a C Corporation Eligible for the Qualified Business Income (QBI) Deduction?

No. According to the Internal Revenue Service (IRS), “income earned through a C corporation or by providing services as an employee is not eligible for the deduction.” A C corporation files a Form 1120: U.S. Corporation Income Tax Return, and it is not eligible for the deduction.

You also cannot deduct any amount of your salary paid by an employer and reported on Form W-2: Wage and Tax Statement. The deduction is available to independent contractors and pass-through firms. They declare their portion of business revenue on Schedule C: Profit or Loss from Business, which is included with Form 1040: U.S. Individual Tax Return.

Which Method is Better for My Business Vehicle: Standard Mileage or Actual Expense?

It is determined by the amount of vehicle-related costs you incurred throughout the year. If you’ve spent a lot of money on maintenance (oil changes, brake pad replacements, new tires, etc.), automobile inspections, and registration, the real expenditure technique may be better for you.

However, if you had little costs this year or drove a lot for work, the 56 cents per mile in 2021 may give a higher expense deduction. It’s also less complicated since you don’t have to maintain meticulous records of all your costs. If you have maintained all of your spending records, double-check your total expense deduction using both methods.

The Bottom Line

Most small company tax deductions are more sophisticated than this quick summary describes—after all, it is the United States Tax Code—but you now have a decent understanding of the fundamentals.

There are many more deductions available than those mentioned here, but these are the most significant. Office supplies, credit card processing costs, tax preparation expenses, and company property and equipment repairs and upkeep are all deductible. Other company costs, however, may be depreciated or amortized, which means you can deduct a tiny portion of the cost each year over a number of years.

Remember to ask yourself, “Is this a regular and essential expenditure in my field of work?” if you’re unsure whether a cost is a genuine company expense. This is the same question that the IRS will ask if your deductions are audited. If the answer is no, disregard the deduction. If you are unsure, get expert assistance with your company tax return from a certified public accountant (CPA) or another accredited tax preparer.

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